Tracey White, owner of the buzz Coffee Shop chain, has decided to expand her operations. Her 2006 financial statements follow. Tracey can buy two additional coffeehouses with either a 10 percent (annual interest) loan or the issuance of new common stock. She also expects these new shops to generate an additional $1 million in sales. Assuming a 40 percent tax rate and no other changes, should Tracey buy the two coffeehouses? Why or why not? Which financing option results in the better ROE?
Buzz Coffee Shops, Inc. 2006 Financial Statements
Balance Sheet
Current assets $250,000
Fixed assets 750,000
Total assets $1,000,000
Current liabilities $300,000
Long-term debt 0
Total liabilities $300,000
Common equity $700,000
Total liabilities and $1,000,000
Stockholder's equity
Income Statement
Sales $500,000
-Costs and expenses@40% 200,000
Earnings before interest and taxes (EBIT) $300,000
- Interest expense 0
Net profit before taxes $300,000
- Taxes @ 40% 120,000
Net income $180,000